Download Review notes chapter 6

Review notes chapter 6
Be careful with this material. Remember to look at the positive aspects first. Then you
can address the normative aspects after learning about the cost/benefits of the choices you
are facing.
Demand is the group of Marginal Benefit points at each quantity. We know this because
it is defined as the maximum quantity at each price. The consumer will always want
more if there is a consumer surplus on a given unit (more benefit than cost). Therefore
they will continue expanding output desired until the break even on a unit. Therefore, the
last unit (shown on the demand curve) has the same benefit as cost. That is for this unit,
marginal benefit equals marginal cost.
Similarly, Supply is the group of Marginal Cost points at each quantity. We know this
because the supply is defined as the maximum quantity the supplier is willing to sell at
each given price. If there is a producer surplus (price in excess of cost for that unit) the
seller will want to sell more (to receive more surplus). Thus, the last unit that they are
willing to sell has no surplus on it. Therefore the Marginal Benefit (in this case price) is
equal to Marginal Cost (the addition to total cost caused by this unit).
Consumer surplus on one unit is the excess of Marginal Benefit over price paid.
Producer surplus for one unit is the excess of price received over Marginal Co0st.
The cumulative Consumer Surplus is the sum of the Consumer surpluses for all units
purchased.
The cumulative Producer surplus is the sum of the Producer Surpluses for all units sold.
Efficiency is getting the most output given resources available. The competitive market
economy is efficient when dealing with private (rival consumption) goods. This is
because individual consumers will purchase goods as long as the price is less than or
equal to their Marginal Benefit, and suppliers will sell goods as long as the price received
is equal to or greater than the Marginal Cost. As long as price is allowed to vary freely,
surpluses and shortages will drive the price to that price for which Marginal Benefit
equals Marginal Cost. In this situation, all units for which either Consumer Surplus or
Producer Surplus (or both) are positive are sold. And, no units for which there is a
negative surplus will be sold.
Any restrictions on the market which force the market away from the competitive
equilibrium create dead weight loss. Dead weight loss is uncompensated loss. If there is
a decline in Consumer benefit, there will usually be a decline in supplier cost. This
change is a wash (does not change the wellbeing of the economy). However, if the
Consumer benefit lost is greater than the Producer Cost saved, the difference is dead
weight loss, and constitutes an uncompensated loss for the economy.
Taxes raise (subsidies lower) the demander’s price (without changing the seller’s cost) so
less units (more units) are demanded (Qd down). This leads to fewer units and a dead
weight loss.
Price ceilings force price below equilibrium, decreasing the supplier’s willingness to sell.
A permanent shortage results and fewer units are produced creating a dead weight loss.
Price floors force price above equilibrium, decreasing demander’s willingness to buy (Qd
down). This creates a permanent surplus and results in fewer units being sold creating a
dead weight loss.
Externalities are costs (or benefits) borne by individuals other than the consumer or
producer making the decision. Because of this there will be too many (few) goods
produced (from the perspective of society). This leads to a dead weight loss.
Public goods are goods which can be simultaneously consumed by more than one
consumer. Thus the total value created by a given unit is the sum of the benefits. The
free market is not good at allocating these goods because of the Free rider problem,
where each consumer can experience the consumption without the cost if others
consume. Individual consumers will each have an incentive to let others pay for the
good. Thus, not enough of the good will be produced by the free market.
Common resources can be utilized by multiple producers, but they each do not see the
cost they are inflicting on other producers. Thus, there will be overproduction as each
producer sees an underestimate of the true cost (this is a negative externality situation).
Monopoly is a situation in which one firm controls a given market. The monopolist has
an incentive to restrict output (we will talk a lot about this later).